CSR AND FINANCIAL PERFORMANCE
Abstract
Organizations and investors have shown an increased interest in corporate social responsibility despite the uncertainties concerning whether the activities involved create financial value. This has led to an increase in studies evaluating the relationship between an organization’s financial performance and its corporate social responsibility activities. The studies have provided conflicting results. The research aims to determine whether engaging in corporate social responsibility directly impacts the performance of an organization in terms of stock returns. The examination uses FolkSam’s Index of CSR as one of the main points of reference. Three samples have been used from the population and contain bottom and top 31 ranked organizations as well as those labeled as “zero performers.” The methodology uses a classical approach as it employed the market estimation model to evaluate abnormal and normal returns. The results show that being top-ranked does not affect the organization’s stock returns of the bottom-ranked companies that are negatively affected. The negative impact has shown a rise over time. This shows that even though organizations that post good performance in CSR do not enjoy rewards, organizations that perform poorly are still punished. The results also show that more companies are now engaging in corporate social responsibility. Don't use plagiarised sources.Get your custom essay just from $11/page
Introduction
It is challenging to measure and determine the impact of an organization’s investment in CSR. CSR definition is varying and vague making it difficult to measure it despite the research conducted on the subject. Both proponents and opponents of corporate social responsibility try to show the benefits and the disadvantages of engaging in CSR. Some sections claim that engaging in corporate social responsibility is the misuse of scarce resources, and organizations should use their resources for value-adding activities. However, others argue that organizations have an obligation to engage in social responsibility. The interest in undertaking corporate social responsibility has increased over time. However, the activities being performed are significant as a result of stakeholder interest. The pressure is applied by different stakeholders, including the community groups, customers, governmental and non-governmental organizations, and suppliers. Many studies have been undertaken concerning the relationship existing between financial performance and CSR. However, studies concerning whether the ratings about CSR activities impact organizations’ stock prices are hard to find. This makes it interesting to undertake a further investigation on the subject matter, and the study aims to evaluate whether the stock market has any reaction concerning publications of companies’ performance in corporate social responsibility.
Purpose
The aim of the paper is to undertake an investigation concerning the effect of corporate social responsibility of an organization’s financial performance. It examines previous studies and theoretical research and uses event study results to provide a detailed discussion and conclusion about the relationship between CSR and organization performance. Previous research has not provided clear results concerning the relationship between performance and CSR, and little evidence exists that supports the assertion that there is a direct relationship between CSR and a firm’s financial performance (Bratenius and Melin, 2015). Still, many organizations are investing heavily in socially responsible activities. This is implying that there may be financial benefits that are being gained. The study’s purpose is to filing the existing gap concerning research on the subject matter and provide both investors and organizations with better information concerning how CSR efforts may add value. This shows that the results are crucial to both parties as well as stakeholders.
Research questions
Important questions that will be investigated are
Is there any impact of CSR activities on an organization’s stock price?
Does engaging in corporate social responsibility activities add an organization’s financial value, and hence, does CSR work benefit stakeholders?
If CSR is not beneficial to an organization’s value and stakeholders, why do they still involve themselves in expensive CSR activities?
To answer the above questions, CSR motives and relevant concepts are evaluated. An analysis of the Swedish financial market is undertaken before analyzing the potential link between financial performance and CSR activities: the literature and theoretical review guide in the development of the hypothesis.
Literature review
According to Bratenius and Melin (2015), CSR can be considered as strategic when an organization enjoys substantial business-related benefits as a result of engaging in those activities and in particular by offering support to main business activities and process and contributing to the effectiveness of an organization in attaining its vision and mission. Five different corporate strategy dimensions necessary for the success of an organization include visibility, specificity, centrality, voluntarism, and proactivity. The five are used to assess how a firm value can increase as a result of engaging in corporate social responsibility.
It is argued that the dimensions may lead to the attainment of benefits, including environmental management, employee benefits, and philanthropic contributions, which in turn can ensure that value is created, including productivity gains, customer loyalty, and new markets and products. Five areas demonstrating beneficial CSR activities impact includes organization reputation and image, human resources recruitment, retention, and motivation, increase in sales through improved market share, cost savings, risk management, and reduction. The competitiveness of an organization can be enhanced by its reputation and image; thus, it benefits it.
Source: (Bratenius and Melin, 2015).
According to research, CSR positively impacts reputation and image, showing that it may have an indirect influence on the company value (Bratenius and Melin, 2015). Enhanced reputation can also help in the recruitment, retention, and motivation of human resources. Employees may be motivated by working in better living conditions and being engaged in voluntary activities. Future employees may also see the organization as an attractive option. The implementation of a sustainable strategy can ensure that an organization improves on aspects like material efficiency, energy consumption, and time savings allowing it to save on cost. This could also ensure that a positive reaction from customers is generated because they may be one of the cost savings beneficiaries.
Source: Obeidat 2016
The improvements can also be viewed as a positive thing by investors and financial analysis concerning the performance of the organization. Engaging in CSR activities may enhance the brand image of an organization and positively impact its market share and revenue. The activities can also reduce negative publicity risk or non-profit making organizations related pressures. This can also lead to gaining financial advantages like avoiding fines. The figure below by Weber shows how corporate social responsibility may benefit an organization.
Source: Mahrani and Soewarno: 2018
Both non-monetary and monetary benefits are enjoyed by an organization that engages in CSR activities. Direct monetary activities can be viewed as primary value drivers, while non-monetary can be regarded as secondary value drivers. Both can, however, allow an organization to gain financial advantages such as company competitiveness.
According to Cho, Chung, and Young (2019), organizations that actively engage in CSR activities may enjoy a lower level of cost of equity compared to those organizations that post low performance concerning CSR. Organizations engaging in limited CSR or those who do not partake in these activities at all have higher perceived risk and reduced investor base. The explanations for this include investor preferences and information asymmetry. Investors show higher preferences concerning investing in an organization that engages in high CSR activities because they assume that it brings out a positive image (Giannarakis et al. 2016). This attracts more investors and can have a positive impact on company value. This shows that organizations that engage in CSR may have a higher chance of obtaining or attracting investors compared to their counterparts. This shows that engaging in CSR activities may lower the cost of capital of an organization.
Incorporating CSR activities in the valuation of a company
Discussions are still ongoing concerning how the value of an organization can be enhanced by its participation in CSR activities. Some of the initiatives associated with CSR, including reducing energy usage, have more immediate results making it possible to assess the value. Other activities like letting the human resources be involved in voluntary activities may prove to be beneficial because they might create value in the form of motivation of the employees hence efficiency. This can ensure that more long-term benefits are attained, making it difficult to assess. One can include social responsibility activities under the strengths and opportunities of an organization’s SWOT analysis. However, a McKinsey survey shows that some investors to not take into account fully CSR value when making investments decision and valuation because the value is seen as too challenging to measure, too indirect, and too long-term. Some investment professionals also agree that engaging in CSR activities does not mean that an organization will create value, and the most crucial aspects maintained is having a good corporate image and reputation. The chart below shows how a CSR program contributes to an organization’s value in the long-term based on 150 respondents.
The correlation between the financial performance of an organization and its social corporate responsibility activities is considered important with the management and business areas. Investors also show interest in this relationship. Even though the primary responsibility of organizations is ensuring that the shareholders realize value for the amount invested, they can concurrently contribute to both the environmental and social goals. They can ensure that social responsibility has been integrated as a crucial part of their strategic management. Organizations are not guaranteed that participating in corporate social responsibility will allow them to attain value for the shareholders. However, the approach can allow the organization to gain social protection, making it possible to maintain value.
Source: Fernandez 2015
The research undertaken concerning the relationship between financial performance and CSR activities can use different values and approaches. The studies consider the financial performance of an organization as the dependent variable. However, other studies consider social concern or CSR performance as the dependent variable. Research concerning the relationship between the two aspects using financial performance as the dependent variable has demonstrated ambiguous results. Different studies have been conducted showing either positive, negative, or no relationship between the corporate social responsibilities of an organization and its financial performance. A recent study was undertaken by Hassel, Nilsson & Nyquist (2005) shows that it is costly to have high environmental performance, and making such an investment can have a negative effect on the organization’s market value and expected earnings. According to them, the environmental performance of an organization can be seen as window dressing of both financial performance and book value by investors.
A study undertaken by Klassen and McLaughlin showed that there was a relationship between public announcement concerning environmental performance reward of a certain organization and stock market performance. They present evidence in this study to support their assertion that stock returns were positively impacted by strong environmental management. There also found out that first-time rewards had a significant impact on the valuation in the market. Another study found out that there exists a correlation between financial performance and social performance. It was based on the activities of 67 large companies in the United States between 182 and 12
A more recent study claims that the demand and supply of corporate social responsibility investment opportunities mainly determine the CSR investment’s impact on an organization’s market value. The study assumed that some of the investors’ main preferences to invest in organizations involving themselves in socially responsible activities. By involving themselves in CSR activities, organizations reach and attract investors who place value in such activities even though they may negatively impact their present cash flow value. A positive relationship may exist between the value of a firm and socially responsible investments (Kumar et al. 2018). The author also constructs an equilibrium showing where socially responsible investment supply and demand meet. According to the author, if the demand by investors for responsible investment opportunities is more compared to their supply, this shows the absence of enough organizations engaging in these activities, and thus, such investments can allow a firm to create economic value. The following figure shows the possible relationship existing between CSR activities of an organization and its financial performance.
Source: (Bratenius and Melin, 2015).
Data
The research is a secondary analysis, and data has been gathered from other institutions, which has been primarily collected for other purposes or needs. Using such data presents a researcher with several benefits. They include the high quality of data because the sampling process was rigorous, and the organizations responsible for data collection are reliable and accredited. The primary researchers also have many years of experience, and the data has been subjected to quality checks and associated procedures. However, it is crucial to remember that quality checking may not have happened, meaning that some caution should be taken when using the data.
To ensure proper examination and analysis of the problem statement and developing an appropriate answer for the questions developed, qualitative data representing the prices of stock for organizations in the population and OMX Nordic Stockholm index are used. The extraction of the needed data using Thomson Reuters Datastream on the number of employees, turnover, total assets, and market capitalization has been undertaken. The research has chosen a database that is widely used and regarded as an authentic and reliable means for gathering data. The study would have used an alternative source like Bloomberg, but its reputation is similar to Thomson Reuters Datastream. The study has also used the OMX Nordic Stockholm Price Index. It includes different stocks that are helpful for the analysis and discussion of the problem statement. The research also uses organizational documents to analyze the CSR-rankings in the market. It has used the Folksam CSR ranking report, which is based on the global compact guidelines of the United Nations. The raking can be employed on a global scale showing its reliability and uniformity.
Data adjustment
During the event study execution, adjustments have been undertaken to ensure the attainment of accurate results. For instance, when undertaking an estimation of the stocks’ normal returns, the returns used for the estimation window are applied in the linear regression to ensure that a proper estimation concerning what would be the normal return. Events like acquisitions and mergers, among others, are adjusted to ensure that there is an accurate and unbiased normal return estimation.
Methodology
Folksam CSR ranking report is used and includes the ranking and study of Swedish Listed companies. The report uses information on organizations’ engagement with aspects like human rights and the environment and how well they handle risks associated with such areas. The assessment is based on the publicly available information for the organizations involved. The information is found in different sources, including their sustainability reports, annual reports, and websites. Information is also gathered from other sources like governments, international organizations, and media to ensure that the data gathered directly from organizations is checked and complemented. The collected materials are used to make the final judgment. An environmental analysis consisting of the environmental management system assessment is undertaken. The criteria used for the analysis include evaluating environmental plans and policy, the organization and management system, external certificates, supply chain management, and environmental reporting.
The human rights analysis considers the role of the organization as a member of the society, the human rights concerning supply chain operations, and the employees. Each evaluated criteria concerning the analysis of human rights and environmental analysis are allocated 0 to 7 points. Organizations that have covered all the criteria components are given maximum points. Points are also received if reporting shows that the organization is improving concerning management plans and system and policy. Industry risk and performance are also evaluated by the Folksam report, especially concerning CSR. The information source is reliable because it is a well-renowned index that analyzes all the organizations that are listed in the stock market in Sweden.
Analysis and findings
The top organizations’ cumulative average annual returns are stable overall days, even though it is negative. This shows that the top-performing organizations’ stock returns were negatively impacted by the CSR ranking report. The results show that the top-performing organizations are not significantly impacted by ranking reports when an aggregate of all the years is done.
Series 3= zero
Column 1= bottom
Series 1= top
However, the release of the report negatively affects the zero and the bottom performing organizations. This shows that investors consider low or zero rankings concerning CSR activities as negative information; thus, they would have an issue with such kind of a company when making an investment decision (Bratenius and Melin, 2015). The downsloping trends show that few organizations are ignoring to report on matters concerning CSR showing that CSR engagement is becoming crucial. The results show that there is an overall negative impact. However, there is a possibility of segment differences, making it necessary to conduct further tests. This means that the data available should further be re-grouped to gain better insight concerning different industries and abnormal returns. The graph representing the number of zero companies is presented below
Conclusion and recommendations
The study concerning the impact of CSR activities undertaken by an organization on its financial performance shows that although top perfuming companies may not experience significant changes, the zero and bottom companies’ value may be affected because investors may be concerned by their performance. The studies also show that the organization is increasingly embracing corporate social responsibility activities, and this trend is expected to continue in the future. Investors will become more informed about the CSR activities of the organizations showing the need to improve on these activities and ensure that an organization becomes a responsible member of the society.
Organizations across the world should become socially responsible and integrate their corporate social responsibility practice into the overall corporate strategy. Some of the practices that should be embraced include protecting the environment, protecting the rights of everyone, and attempting to reduce poverty on national, local, and global levels. Being a socially responsible company will allow a business project a positive image and gain reputation to shareholders, consumers, and investors positively affecting its bottom line. Socially responsible companies are in a position to attract and retain competent human resources allowing them to enjoy long-term growth and success. Organizations should embrace a sustainable business model that considers the economic, social, and environmental aspects. The management should also understand that dissatisfaction of stakeholders like customers, employees, and the investors can have an effect on economic rent and may compromise the future of an organization.
List of references
Bratenius, A., and Melin, E., 2015. The Impact of CSR on Financial Performance – An event study of abnormal stock returns of Swedish companies as a reaction to the release of the Folksam Index of Corporate Social Responsibility. [online] Available at: <https://research-api.cbs.dk/ws/portalfiles/portal/58411722/anna_linnea_helena_braatenius_og_emilie_josefin_melin.pdf> [Accessed 19 March 2020].
Cho, S.J., Chung, C.Y. and Young, J., 2019. Study on the Relationship between CSR and Financial Performance. Sustainability, 11(2), p.343.
Giannarakis, G., Konteos, G., Zafeiriou, E., and Partalidou, X., 2016. The impact of corporate social responsibility on financial performance. Investment management and financial innovations, (13, Iss. 3 (cont. 1)), pp.171-182.
Hassel, L., Nilsson, H. & Nyquist, S., 2005. The value relevance of environmental performance. European Accounting Review, 14 (1): 41-61
Kumar, A., Sinha, A., Arora, A., and Aggarwal, A., 2018. Impact of CSR activities on the financial performance of firms. MUDRA: Journal of Finance and Accounting, 5(1), pp.75-89.
Mahrani, M., and Soewarno, N., 2018. The effect of good corporate governance mechanism and corporate social responsibility on financial performance with earnings management as a mediating variable. Asian Journal of Accounting Research.
Obeidat, B.Y., 2016. Exploring the relationship between corporate social responsibility, employee engagement, and organizational performance: The case of Jordanian mobile telecommunication companies. International Journal of Communications, Network and System Sciences, 9(09), p.361.
Rodriguez-Fernandez, M. (2016). Social responsibility and financial performance: The role of good corporate governance. BRQ Business Research Quarterly, 19(2), 137-151.